Fully invested funds could post non-cash for variation margin, says CCP

Eurex reports that it has made progress on offering investors the ability to source cash using a repo transaction cleared through the CCP.

Pension funds and their asset managers could soon be in a position to use a centrally cleared model for repo transactions, in order to source the cash collateral needed for variation margin to post against centrally cleared OTC derivatives.

According to Eurex, the central counterparty (CCP) clearinghouse, progress has been made on the initiative, which would effectively allow a buy-side client to post non-cash assets for variation margin purposes, and then convert them to cash via the CCP’s own repo clearing service.

 “Every CCP around the globe works with cash as variation margin.” Said Matthius Graulich, Head of OTC Development at Eurex, the CCP arm of Deutsche Borse. “What we’re looking at and have made a few steps in is where we can provide the repo service as well. We would make the asset manager a special member of the CCP. They would then provide securities and then cash providers can come to provide cash to asset managers just to provide them cash for variation margin. It has an advantage for buy-side because they don’t have to hold big piles of cash. It has advantages for the sell-side cash providers, because they don’t have the counterparty risk of facing a buy-side institution but instead face a CCP. The closer the capital rules and CRD4 come the more interest we get in that.”

Fully invested pension funds and other asset owners and managers typically do not hold significant quantities of cash. However, as the central clearing of swaps mandated under EMIR (European Markets Infrastructure Regulation) is introduced, users of derivative contracts including interest rate swaps, will be required to post initial margin in the shape of high quality securities and variation margin, which is always in cash, to CCPs in order to collateralise the contracts.

Some commentators have suggested that for pension funds to hold and/or source cash via a collateral transformation service (such as a repo) could be expensive. And others have also questioned whether EMIR’s intention was to force cash-poor investors into repo transactions to find variation margin.

Earlier this year, Steven Maijoor, the Chair of the European Securities and Markets Authority (ESMA) – the body responsible for executing EMIR legislation – said that he expected CCPs to develop methods for taking non-cash assets for variation margin.

Christian Lee of clearing consultants Catalyst said that it would be difficult for any CCP to accept bonds for variation margin. “By taking bonds instead of cash the CCP would be assuming considerable treasury investment risk which should only be handled by a sophisticated treasury division,” he said.

Lee added that if cash-poor investors were to begin using bilateral repo transaction to find cash to allow them to clear OTC derivatives contracts, it would simply transfer risk from one place to another. He said that an OTC derivative clearing service incorporating a repo clearing service could be a solution. 

Tags: CCPEurexEMIRESMAOTC Derivatives